The Second Arrow of Likonomics

Assistant Research Fellow, China Institutes of Contemporary International Relations

Premier Li Keqiang revealed more information about his Likonomics plan, and the future prospects for China’s economic reform in the 2014 Report on the Work of the Government.

Over the past year, some foreign media and investment institutions have speculated about the new Chinese government’s economic reform policies. The creation of Likonomics by Barclays Bank was especially impressive. Barclays believed that the Likonomics contained three basic elements: a cautious manner to economic stimulus measures, the deleveraging of financial sectors, and the structural reforms of the Chinese economy, which are regarded as the central idea of Chinese leadership to design the economic reform program. In 2013, the supervision of the shadow banking system, the further liberalization of the interest rate market, and the so-called money shortage seemed to confirm Barclays’ speculation. They worried that higher interest rates, increasing bad debts, and the shrinking of industrial production could lead to a significant decline in China’s economy, and that the Chinese leadership would let it happen. Therefore, negative views of China’s economy proliferated during the second half of 2013.

Barclays’ analysis of Likonomics correctly understands that the Chinese leadership strengthens the vitality of the market and expands the role of the market in the national economy, but it ignores the role of the Chinese government in economic reform. To release the vitality of the market and let the market play a bigger role does not mean that the government will become unresponsive in the face of risks and crisis. Likonomics is different from laissez-faire economics, and it is not a stress test for the Chinese economy. The Chinese government does not alternatively choose between small and big government ideas, but leaves market issues to the market, and government responsibilities to the government. It re-clarifies the role of the market and the role of government in economic and social development.

If increasing the role of the market and reducing administrative interventions is the first arrow of Likonomics, then the second arrow is clearing lines of responsibility and the role of government in reform, as explained in the new government work report.

First of all, the Chinese government will become the active regulator of reform, to ensure that the Chinese economy avoids upheavals. The report clearly states that the reasonable range for the Chinese economy in the future will be a GDP annual growth rate of around 7.5%, M2 growth of 13%, and CPI at 3.5%. These indicators are consistent with those of 2013, but the expectations of growth and inflation were lower than 2011. It means the Chinese government has abandoned hard targets on economic growth and inflation, allowed some of the indicators to cross the line, and accepted the fact that China’s economic growth started to slow down. However, the emphasis of the reasonable range means that the Chinese government will carefully assess the situation of the economy and provide crisis intervention if necessary. The clarity of the reasonable range will help stabilize the outlook and enhance market confidence in the Chinese economy.

Secondly, the Chinese government will take responsibility to solve the problems that come with reform. Premier Li Keqiang pointed out two potential risks that the Chinese government should pay particular attention to. One is structural unemployment and the other is a widening wealth gap. In the next few years, the Chinese government will focus on solving these two problems. The target of GDP growth in 2014 is above previous market expectations and, as Li Keqiang said in the report, more efforts will be needed for creating more jobs for rural migrant workers. The report raised the target of new urban jobs from 9 million to 10 million in the last year, which was the highest since 2011. The report also highlighted employment difficulties in outdated industries and among college graduates. The new urbanization may be accelerated to provide more service jobs. In addition, Li also put forward a plan for ‘War on Poverty.’ The report pointed out the key issues for people’s wellbeing to ease the wealth gap and foster a new middle class, which include housing, health care and pension reform. The Chinese government is committed to increasing investment in affordable housing, fundamental health care, as well as the pension system.

Finally, the Chinese central government will become one important supporter of reform and a defender of laws. The report said that the government will increase the size of the deficit arrangement to 1.35 trillion RMB from 1.2 trillion in 2013, which is a 450 billion increase as compared to 2011. It means that the budget of the central government will be the main source of funding to support reform projects. If the budget deficit ratio and GDP remained stable at 2.1%, and the amount of China’s budget deficit stayed at only one sixth of United States’, a modest growth in deficit will not significantly impact China’s fiscal situation. Moreover, expanding the size of the central budget comes with cautious control from local governments. The transfer payments from central to local government will be cut by one third in 2014 and will continue to be cut in coming years. It shows that the Chinese government has learned lessons from the previous four trillion stimulus package. The Chinese government will also work to strengthen the rule of law and legal supervision in environmental protection and fair competition. The Chinese government toughened its on pollution, treating it as the second most important social issue beside poverty. It means that local governments will be under growing pressure to shut down outdated production facilities and illegal sewage companies. In addition, the report also proposed setting up a business blacklist system, allowing public pressure and market mechanisms to punish companies that produce counterfeit products and disturb the market order.

Li Zheng is an Assistant Researcher at the Institute of American Studies of China Institutes of Contemporary International Relations.